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Important farm financial ratios to know

What you need to know about term debt and lease coverage and operating expense ratios.

In the last column, I was sifting through the numbers from the 2018 FINBIN data from the Center for Farm Financial Management at the University of Minnesota while flying over Denver on Delta Air Lines. As the flight has progressed, I am now flying over Salt Lake City on the way to San Francisco while bouncing along with turbulence from the spring snowstorms. Let's dig deeper in the numbers and build on the financial ratios discussed in the last article.

Term debt and lease coverage ratio

One of the favorite financial ratios of many agricultural lenders is the term debt and lease coverage ratio put forward by the original Farm Financial Standards Task Force in 1991. This ratio examines whether one has the ability to service debt through farm and nonfarm earnings and still meet expenses, family living costs and income taxes. Most agricultural lenders would prefer to see the ratio above 125 percent over a three-year trend analysis.

Unfortunately for the participants in the database in 2018, the average producer was far from meeting this benchmark. Over the last four years, the average term debt and lease coverage ratio for producers in the database has been 90 percent. With this ratio less than 100 percent, debt refinancing and restructuring are options being exercised by producers to meet cash flow requirements such as debt servicing. The top 20 percent of producers have a very good standing with an average coverage ratio of approximately 200 percent. This could be the result of strong earnings, low debt service or a combination of both. The bottom 20 percent of producers never generated a coverage ratio greater than 100 percent over the past decade, including the stellar economic times during the recent economic commodity super cycle in agriculture experienced from 2007 to 2012.

Operating Expense Ratio

One of my favorite ratios is the operating expense ratio, excluding interest and depreciation expenses. This ratio, which compares operating expenses to revenue, is all about the margin. In recent years, the average producer had a 16 percent margin or an operating expense ratio of 84 percent. This is down nearly 20 percent from the stellar economic years of the commodity super cycle from 2007 to 2012.

The top 20 percent of producers are still finding some success. Their operating expense ratio is below 75 percent in recent years, which provided a 25 percent margin. However, similar to the average group results, even the top producers experienced a reduction in margin of 15 percentage points.

The bottom 20 percent of producers are struggling with the operating expense ratio in the high 90s, which results in little or no margin. In these cases, off-farm income, low debt service or a combination of both situations are crucial.

This cross country trip has provided ample time to reflect on the numbers from the 2018 FINBIN data. As I travel over the Donner Pass, I can see sites of the Golden State out of the plane window. Hopefully, this two-part series analyzing the numbers has provided you with some vantage points of what your peers are doing in agriculture economics during this challenging economic cycle.

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